Contemporary Mathematics for Business and Consumers Third Edition By: Robert A. Brechner COPYRIGHT © 2003 by South-Western, a division of Thomson Learning. Thomson Learning TM is a trademark used herein under license. ALL RIGHTS RESERVED. No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means–graphic, electronic, or mechanical, including photocopying, recording, taping, Web distribution or information storage and retrieval systems–without the written permission of the publisher. For permission to use material from this text or product, contact us by Tel (800) Fax (800)

Chapter 16 Inventory Copyright © 2003 by South-Western

Chapter 16, Inventory Section I Inventory Valuation 16-1 Pricing inventory by using the first-in,first-out (FIFO) method Pricing inventory by using the last-in, first-out (LIFO) method Pricing inventory by using the average cost metho 16-4 Pricing inventory by using the lower-of-cost-or- market (LCM) rule. Section II Inventory Estimation 16-5 Estimating the value of ending inventory by using the retail method.

Chapter 16, Inventory Section II Inventory Estimation (Cont.) 16-6 Estimating the value of inventory by using the gross profit method. Section III Inventory Turnover and Targets 16-7 Calculating inventory turnover rate at retail Calculating inventory rate at cost Calculating target inventories based on industry standards.

Section I, Inventory Valuation Inventory Valuation 16-1 Pricing Inventory by Using the First-In-First Out (FIFO) Method. Steps to Calculate the Value of Ending Inventory by Using FIFO: Step1. List the number of units on hand at the end of the year and their corresponding costs, starting with the ending balance and working backward through the incoming shipments. Step 2. Multiply the number of units by the corresponding cost per unit of each purchase. Step 3. Calculate the value of the ending inventory by totaling the extensions from Step 2.

Everybody’s Business The value placed on inventory can have a significant effect on the net income of a company. Because net income is the basis of calculating federal income tax, accountants frequently must decide whether to value inventory to reflect higher net profit to entice investors or lower net profit to minimize income taxes.

Everybody’s Business Although the material in this chapter essentially deals with accounting, anyone who plans to own or manage a business involving merchandise should have a conceptual understanding of inventory valuation methods.

16-2 Pricing Inventory by Using the Last-In, first Out (LIFO) Method Steps to Calculate the Value of Ending Inventory by Using LIFO: Step1. List the number of units on hand at the end of the year and their corresponding costs, starting with the beginning inventory and working foward through the incoming shipments. Step 2. Multiply the number of units by the corresponding cost per unit of each purchase. Step 3. Calculate the value of the ending inventory by totaling the extensions from Step 2.

Everybody’s Business One of the main reasons for choosing a particular inventory valuation method is for the calculation of income for tax purposes. When cost are rising : FIFOHigher gross profit LIFOLower gross margin When costs are decreasing: FIFOLower gross margin LIFOHigher gross margin

Section II, Inventory Estimation 16-5 Estimating the Value of Ending Inventory by Using the Retail Method Steps to Estimate the Value of Ending Inventory by Using the retail Method: Step1. List beginning inventory and purchases at both cost and retail. Step 2. Add purchases to beginning inventory to determine goods available for sale at both cost and retail. Beginning inventory + Purchases Goods available for sale Step 3 Calculate the the cost ratio. Cost ratio = Goods available for sale at cost Goods available for sale at retail

Section II, Inventory Estimation 16-5 Estimating the Value of Ending Inventory by Using the Retail Method Steps to Estimate the Value of Ending Inventory by Using the retail Method (Cont): Step 4. Subtract net sales from goods available for sale at retail to get ending inventory at retail: to beginning inventory to determine goods available for sale at both cost and retail. Goods available for sale at retail - Net sales Ending inventory at retail Step 5 Convert ending inventory at retail to ending inventory at cost by multiplying the ending inventory at retail by the cost ratio. Ending inventory at cost = Ending inventory at retail x Cost ratio

16-6 Estimating the Value of ending Inventory by Using the Gross profit Method Steps to Estimate the Value of Ending Inventory by Using the Gross Profit Method: Step 1. Calculate the goods available for sale: Beginning inventory - Net purchases Goods available for sale Step 2 Find the estimated cost of goods sold by multiplying net sales by the cost of goods sold percent. Step 3. Calculate the estimate of ending inventory by subtracting the estimated cost of goods sold from the goods available for sale. Goods available for sale -Estimated cost of goods sold Estimate ending inventory Estimated cost of goods sold = Net sales (100% - Gross margin %)

Section III, Inventory Turnover and Targets 16-7 Calculating Inventory Turnover Rate at Retail Steps to Calculate Inventory Turnover rate at Retail Step1. Calculate average inventory at retail: Step 3 Calculate the inventory turnover at retail. Inventory turnover at retail = Net sales Average inventory at retail at retail Average Inventory at retail = Beginning inventory at retail +Ending Inventory 2

Everybody’s Business Inventory turnover is an important business indicator, particularly when compared with turnover rates from previous operating periods and with published industry statistics for similar sized companies.

16-7 Calculating Inventory Turnover Rate at Retail Steps to Calculate Inventory Turnover Rate at Cost: Step1. Calculate average inventory at cost: Step 3. Calculate the inventory turnover at retail. Inventory turnover at cost= Cost of goods sold Average inventory at retail at cost Average Inventory at cost = Beginning inventory at cost +Ending Inventory 2

Chapter 16, Inventory Inventory Periodic Inventory system Perpetual inventory systemBook inventory Specific identification methodLiabilities First-in, first-out (FIFO) methodLast-in. first-out (LIFO) Lower-of-cost-or-market (LCM)Average cost Retail methodCost to retail price ratio Gross profit methodAverage inventory Target average inventory

Chapter 16 Inventory Turnover-Cost Copyright © 2003 by South-Western

Chapter 16 Target Inventory Target average inventory cost = Target average inventory cost = Copyright © 2003 by South-Western Cost of good sold Published inventory turnover cost Net sales Published inventory turnover cost

Chapter 16 Inventory Valuation-Average Cost Method Average cost per unit = Copyright © 2003 by South-Western Cost of goods available for sale Total units available for sale

Chapter 16 Inventory Estimated-Retail Method Goods available for sale at cost Goods available for sale at retail Estimated ending Ending inventory inventory at cost at retail Inventory Estimation-Gross Profit Method Estimated cost of = Net sales (100% - Gross margin %) goods sold Copyright © 2003 by South-Western Cost ratio = = xCost ratio

Chapter 16 Inventory Turnover-Retail Copyright © 2003 by South-Western